The Striking Price

Betting on the House

Consider buying shares of both CME and CBOE Holdings. CME's rates complex benefits from speculation about the end of QE3. CBOE's VIX options and futures benefit from fear that rising rates will pressure stocks.

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Stop fretting about a possible end to the Federal Reserve's quantitative easing program. Be proactive and establish positions in stocks that stand to gain from uncertainty about interest rates and any fallout on equity markets.

"CME's rates complex benefits from speculation about the end of QE3," says Gaston Ceron, a Morningstar analyst.

And CBOE's VIX options and futures on stocks and other assets benefit from fear that rising rates will pressure stocks.

That helps explain why both stocks are trading at or near 52-week highs, and are up about 40% this year. But there's good reason to remain bullish. Analysts expect CBOE's earnings to climb 12% next year, to $2.21 per share, and CME's to rise 15%, to $3.62 per share.

Those projections could prove conservative if volatility really picks up. CBOE shares closed on Friday at $41.20, or about 19 times 2014 profits. CME closed at $72, for a forward price/earnings of about 20.

Both stocks have options with high implied volatility, and that creates nice opportunities to sell puts to buy the stocks on potential pullbacks, or to sell upside calls and buy the stock.

CONSIDER SELLING CME'S July 70 put, which was recently bid at $1.60. If the stock keeps advancing, you keep the $1.60. If the stock slides below $70, you own the stock. The risk is that the stock slides far below $70 and you buy high that which is low. But that risk seems muted given how trading action is focused on the possible rate change. And consider selling CBOE's September 40 put that was recently bid at $1.25. You keep the $1.25 if the stock continues to advance, and you buy the stock if it dips below $40.

Interest-rate derivatives comprise about 25% of the CME exchange's clearing and transaction-fee revenue—and that amounts to 81% of the exchange's revenue. In May, CME's average daily trading volume was about 14.7 million contracts, up sharply from the first-quarter average of 12.5 million and an April average of 11.6 million contracts. The jump is largely attributable to interest-rate volatility. "It's the first time the CME has been on the offensive in some time," said Richard Repetto, an analyst with Sandler O'Neill.

At CBOE, proprietary index options and futures contracts accounted for 76% of transaction fees in the first quarter, up from nearly 65% in the same year-ago period. From the start of this year through May, VIX trading volume was up 111% from the same period a year earlier, at 16.5 million contracts. Year to date through May, VIX options are up 37% at 61.2 million.

THOUGH SOME PUNDITS WILL quote VIX at 15 as an indication that investors are increasingly sanguine about the future of stock prices, don't believe it. The key message now is not VIX's absolute level but how much VIX is jumping around. On some days, VIX May move about 8% or more, far greater than what is happening in the stock market.

"VIX wouldn't be this volatile if everyone was really sure of this rally," said Justin Golden, a partner in Lake Hill Capital Management, an investment management firm in Manhattan.